China’s Changing Policies Could Create A Huge Oil Demand Deficit

Figures released last week show that China’s crude oil imports in the first half of 2021 declined for the first time in eight years. China has been the world’s largest net importer of crude oil and other liquids in the world since September 2013 and almost on its own created the 2000-2014 commodities ‘supercycle’, characterized by consistently rising price trends for all commodities – including oil - that are used in a booming manufacturing and infrastructure environment. This oil consumption boom from China was a product largely of the 8+ percent average annual GDP growth recorded by the country over that period, with many spikes well above 10 percent. So does this sudden dip in oil imports in the first half of this year – against declining economic growth over the past few years - mean that a major supportive driver of oil prices has gone for good? A noticeable decline in the rate of economic growth in China began in 2012 when it dipped below the key 8 percent figure for the first time since 1990. Since then the true number for China’s GDP growth has been a matter of considerable conjecture as, although the official annual figures have always been above at least 6 percent, traders and analysts are aware that the numbers are subject to extreme political pressures that could not tolerate headline GDP figures of, say, just 3 percent per year, where a number of traders and analysts think it is. Whatever the real figure, the fact remains that up until this latest data release for the first half of this year, China has still accounted for the consumption of 10-14 million barrels per day (bpd) of crude oil since 2012, crossing the 10 million bpd of crude oil imports level in 2019, having overtaken the U.S. as the world’s biggest net importer of crude oil in 2017. 

China had also seemingly dealt with the economic fallout from the COVID-19 pandemic that peaked (to date) in 2020. By just the second week of April 2020 (only three to four months after the virus began to notably surface elsewhere in the world, and just a week or two after the first U.K. full national lockdown was announced) the lockdown of Wuhan - the Chinese city in which the global COVID-19 pandemic began – was eased. Although as an export-led economy, China would still face some trouble in the coming weeks and months, moves were immediately afoot to mitigate these downside risks to its economy.

In fact, even before the easing of the lockdown in Wuhan, China’s industrial sector had been back operating at levels above the pre-COVID-19 rates for over two weeks. According to data released by China’s National Bureau of Statistics at the beginning of April 2020, the official manufacturing purchasing managers index (PMI) – a survey of sentiment among factory owners in the world’s second-largest economy – was 52 in March. Not only was this a huge leap up from the all-time low reading of 35.7 in February but also a reading of above 50 shows that the manufacturing sector was actually growing.

Technically, it can be argued that the unexpected decrease in China’s crude oil imports in the first half of 2021 is a product of the decrease in margins available to China’s refiners given the recent rise in global crude oil prices. However, this also happened - and to a much greater degree - in the second half of 2018 and China’s crude oil imports did not dip then.

This time around it is critical to note that China’s Q2 GDP fell to 7.9 percent year-on-year (y-o-y), slightly lower than the 8.0 percent median forecasts of analysts covering the sector. “Aside from the fading favorable base effects, quarterly gains of 1.3 percent quarter-on-quarter [q-o-q] were on the back of downward revisions in the Q1 print,” SEB’s Singapore-based head of Asia strategy, Eugenia Victorino, told OilPrice.com last week. “While the June activity indicators managed to beat low expectations, momentum in growth remains imbalanced, with growth in retail sales easing to 12.1 percent y-o-y from 12.4 percent in May but the compound growth rate in the last two years eased to 4.9 percent in June from 8.0 percent in 2019, indicating that household spending remains far from pre-pandemic trends,” she said.

“Meanwhile, residential property sales are quickly losing steam due to the rising mortgage rates and thus we are cautious of the stalling recovery in private consumption,” she added. “Additionally, the credit impulse has declined sharply in the last quarter and, historically, the credit cycle has a six-month lead, indicating a continued decline in sequential growth in the near term,” she underlined. “The broad-based reduction in the reserve requirement ratio that came into effect on 15 July should provide some offset to the easing growth momentum but whether this is enough to prolong the recovery is not yet clear,” she concluded. 

The situation in which China finds itself may underpin the view that the country is no longer interested in playing the sort of leading role in the economy of the globe as it has done for the past 10-20 years in particular, which is even more concerning for those with a bullish take on future oil prices. “There was a time when China’s credit impulse was the most important piece of data in global macro and, for almost a decade, the country has been locked in a stop-go policy pattern, with every oscillation in China’s domestic monetary/fiscal stance eventually producing powerful swings in the broader global industrial cycle,” Dario Perkins, managing director of global macro for TS Lombard, in London, told OilPrice.com last week. “To be precise, if China tightened, the world could expect a deflation scare, typically around eight to ten months later and if the authorities eased then reflation would become the big theme,” he said.

This enduring correlation between China’s economic measures and the rest of the world seemed to go far beyond traditional trade links, including China’s role as a source of final demand, which, thinks Perkins, was – and has remained – a function of the fact that with the developed economies suffering secular stagnation and central banks powerless to stimulate demand, China had become the world’s main source of ‘balance sheet’. “By adding 30 percent of world GDP to the Chinese Communist Party balance sheet, the country had become the marginal source of demand for the entire global economy but this leaves a problem – because China no longer wants to play this role,” added Perkins. 

More specifically, he underlined, Beijing has adjusted its economic objectives and is now less willing to engage in big credit stimulus, with the central Chinese authorities now cognizant of the fact that continued rapid debt build-up poses a risk to future growth and to social stability and national security as well. This ties into moves seen since 2017 in China that have broadly signaled a shift from credit-fuelled expansion to an emphasis on slower sustainable development, and have included a crackdown on shadow banking, tackling legacy debt burdens, and removing explicit GDP targets. This shift can also be seen in China’s response to the COVID-19 pandemic compared to its response to the first significant onset of the global financial crisis in 2008. According to figures from TS Lombard, in 2020 China’s COVID-19 stimulus was 10 percent of GDP (versus 13 percent in 2008), compared to 26 percent of GDP in the U.S., 40 percent in Germany, and 24 percent in France. “China’s stop-go policy cycle is still there, but the threshold for intervention is higher and the scale of stimulus is likely to be smaller,” said Perkins. 

So, what does this mean for global growth and, by extension, for oil demand? “Short-term, the world’s economic ‘cycle’ - if you can even call it that - is dominated by COVID, with the contractions and expansions associated with lockdowns and reopening comfortably dwarfing any spillovers from Chinese policy, either direct or indirect,” he underlined. But after the developed world has settled into a new normal in which COVID-19 or whatever subsequent variant comes along is dealt with and regarded in a similar manner to influenza – yearly mass vaccinations and the acceptance of a certain death rate per year -  then China’s shift in policy will leave a huge gap in global demand for oil (and all other commodities that are used in a booming manufacturing and infrastructure environment that Beijing has been buying up over the past 30 years). “If China is truly falling out of love with State stimulus then the world is going to need an alternative source of demand if it is going to avoid an even more stagnant economy than before COVID-19,” Perkins concluded.